Bitcoin mining industry analysis

The Bitcoin network is the first payment transaction system that successfully applied blockchain technology. Without the credit endorsement of a centralized institution, the "trust value" of the system is created by its encryption algorithm and consensus mechanism; and its pioneering "mining" behavior has encouraged more network nodes to join in, maintaining and increasing the "trust value" of the system. Bitcoin mining, in one sentence, means "competing for the system's accounting rights and obtaining Bitcoin as a reward." To expand on the concept, you need to know "how to mine" (PoW consensus mechanism) and "what to mine" (incentive mechanism)

• "How to mine": Following the PoW consensus mechanism, that is, the Proof of Work mechanism, is the "rule of the game" for users to compete for the right to record accounts. It ensures that the huge distributed network can reach a consensus. At the same time, because users have to pay a price (computing resources and time) to compete for the right to record accounts, the PoW consensus mechanism also limits the noise and intentional attacks in the network, ensuring the security of the network.

• "What to mine" : The incentive mechanism ensures that enough users are willing to participate in bookkeeping, and the addition of more computing resources will make the system more stable and secure, thereby improving the "trust value" of the system.

  
  

The corresponding incentive mechanism is as follows: each user who successfully records an account will receive a bitcoin issued by the system and a transfer fee provided by the transaction party as a reward. When the Bitcoin network was first created (2009), the system would reward users who successfully recorded an account with 50 bitcoins each time, and then halved every four years. In the current cycle, the system will reward users who successfully recorded an account with 12.5 bitcoins each time. The transfer fee is set by the transaction party, and transactions with high fees will be packaged into the block first. Currently, the transfer fee accounts for about 10% of the total mining revenue. Given that the bitcoins rewarded by the system after successful accounting are all set by the system and issued for the first time, this is somewhat similar to the mineral resources buried deep underground. Therefore, we will figuratively call this behavior of providing computing resources and competing for the right to record an account "mining", the users participating in mining are called "miners", the computing resources used are called "mining machines", and the computing resources possessed by the mining machine are called "computing power", which specifically refers to the ability of the mining machine to perform hash operations, and the total network computing power refers to the sum of the computing power of the mining machines in the entire network. The mining difficulty is set by the system and automatically updated every 14 days. It changes synchronously with the computing power of the entire network.

A Bitcoin mining machine is essentially a computer, and its core component is a computing chip . Specifically, the current mainstream Bitcoin mining machines are mainly composed of the following parts: a computing board containing a computing chip and a heat sink, a fan, a controller circuit board, an aluminum alloy shell, and an external power supply. The most core component is the computing chip. The computing performance and power consumption of the mining machine are determined by the computing chip, and its cost accounts for about 80% of the total manufacturing cost of the mining machine.

"Power consumption per unit of computing power" is the core indicator for evaluating the performance of mining machines . When purchasing mining machines, miners usually do not consider the price of a single unit, but focus on the payback period, among which the key indicator is "power consumption per unit of computing power". Under the same computing power, the lower the power consumption of the mining machine, the better the performance of the mining machine. The so-called "power consumption per unit of computing power" is the power consumption/computing power of the mining machine. With the overall improvement of the computing power of the entire network, it will become more and more difficult to successfully mine. Therefore, mining machines need to be replaced regularly to maintain the original income. In recent years, mainstream manufacturers usually upgrade their product series once a year, and may release updated versions to fine-tune performance, power consumption, and price according to market conditions. In this process, the computing power of a single mining machine is constantly improving, while the core indicator "power consumption per unit of computing power" is constantly decreasing.

To optimize the "power consumption per unit of computing power", it is necessary to replace general-purpose chips with special-purpose chips. The development of Bitcoin mining chips has gone through four stages from CPU, GPU, FPGA to ASIC . In this process, the chips that provide computing power have gradually shifted from general-purpose to mining-specific chips . The characteristics of ASIC are that it is oriented to specific algorithm requirements. Compared with general-purpose integrated circuits, it has the characteristics of smaller size, lower power consumption, improved reliability and lower unit cost in mass production. Bitcoin mining is a repeated calculation under a specific algorithm, so the application of ASIC solutions will greatly improve chip performance.

ASIC mining chips have advanced manufacturing processes and fast product iterations. Advanced chip manufacturing processes can improve the precision of integrated circuits, allowing the characteristic dimensions of electronic devices to continue to shrink, thereby continuously improving chip integration, reducing power consumption while increasing chip computing power. In order to obtain optimal performance, the design and manufacture of ASIC mining chips have always been at the forefront of the chip industry. Currently, the mainstream ASIC mining chips on the market have been upgraded from 110nm, 55nm, and 28nm to 16nm, and 7nm ASIC mining chips will also be launched in the next six months . For example, the following are the products and chip iterations of Canaan Creative, the world's second largest Bitcoin ASIC mining machine supplier:

The participants in the Bitcoin-related value chain are as follows: the upstream is the design, production, testing, packaging, and sales of mining machines; the midstream is the mining pools and mining farms; the downstream is Bitcoin exchanges and wallets:

The upstream provides mining machines for Bitcoin mining . This includes fabless manufacturers, such as Bitmain and Canaan Creative, which are mainly responsible for chip design, mining machine assembly and sales, and outsource the manufacturing, testing and packaging of mining machine chips to foundries; it also includes foundries that are responsible for manufacturing, testing and packaging, such as TSMC and ASE.

Mining is carried out in the middle reaches to confirm transactions in the network, and the newly issued Bitcoins flow into the market through it . Due to the exponential increase in the computing power of the entire network, the probability of individual mining success is almost zero. Therefore, large and small mining farms and mining pools have emerged, which compete for the right to record accounts by gathering the computing power of a large number of mining machines to increase the probability of successful mining. The main participants include Bitmain, Bitfury, BTC.com, Antpool, F2pool, etc.

Downstream are Bitcoin transaction, usage and storage service providers . Bitcoin exchanges can provide transactions between legal currency and Bitcoin, and Bitcoin and other cryptocurrencies. Relevant exchanges include Coinbase, Bitfinex, OKCoin, Huobi, etc. Bitcoin payment transfer and storage functions can be completed through Bitcoin wallets. Mainstream wallets include Blockchain, BitPie, etc.

Upstream foundries: limited advanced production capacity, strong voice

Bitcoin mining machine suppliers generally adopt a fabless model. That is, they are only responsible for the design of mining machine chips, while outsourcing the production, testing, and packaging of chips to third parties. Since the chip manufacturing process requires huge capital expenditures, this model allows Bitcoin mining machine suppliers to focus on the core of the product - chip research and development, while obtaining production capacity with reasonable pricing and advanced processes.

Upstream foundries have a strong voice, and only customers with large orders, high prices, and prepayments can lock in production capacity first . Since the foundries that can be selected are industry leaders with limited production capacity, and the major mobile phone chip manufacturers (Apple, Qualcomm, Huawei, etc.) are also competing for the foundry production capacity share at the same time, the mining machine suppliers have relatively weak voice in upstream foundries. Only those with large orders and high prices can become the priority customers of the foundries, and they need to lock in production capacity in advance in the form of prepayments, which puts forward threshold requirements for the scale and capital flow of mining machine suppliers.

Limited production capacity + oligopoly make Bitcoin mining machine suppliers have strong bargaining power with downstream . In recent years, the price of Bitcoin has continued to rise, driving new demand for mining machines. Under the conditions of limited production capacity (limited by foundry capacity) and oligopoly, upstream mining machine suppliers have absolute pricing power over mining machines. Naturally, the price of mining machines is also rising. When the price of Bitcoin soared at the beginning of this year, the Antminer S9 was once sold at a futures price of 34,000 yuan in the Huaqiangbei market. So, how are mining machines priced? Using historical price data, we make the following analysis:

Current mining machine price = fixed payback period × current mining daily income

By plotting the historical monthly mining machine prices and the average daily mining income of the month (here only income, not profit, that is, excluding electricity, rent and other costs), we can see that there is a linear relationship between the current mining daily income and the current mining machine price. We interpret it as the following formula: P = D×(R - C), where P is the mining machine price, D is the payback period, R is the current mining income, C is the current mining cost, and R - C is the current mining income. That is, the current mining machine price is positively correlated with the current mining daily income.

Based on the above results, we get the pricing strategy of the mining machine supplier: the payback period is fixed at about 180 days, and the price of the mining machine is dynamically adjusted according to the current mining income.

It is worth noting that in such a pricing strategy, the daily mining income is static, that is, assuming that the daily mining income remains unchanged in the future, the payback period can be guaranteed to be 180 days. If the future coin price rises and the daily mining income increases, the actual payback period will be shorter, otherwise it will be longer.

From the perspective of mines and miners, buying mining machines for mining is an investment activity, and its demand is affected by the "expected rate of return" . As an investment product, the demand for mining machines will only be higher if the expected rate of return on investment is higher and the risk is lower. It is generally believed in the market that it is the "mining income" that affects demand, but through previous analysis, we found that the purchase price of mining machines will be dynamically adjusted with the current "mining income", so the mining income rate and static payback period do not change in theory, and there is no way to talk about affecting demand. What really affects demand is the "expected mining income". Specifically, if everyone expects future mining income to be higher than the current mining income, then the expected payback period will be shortened, and the "expected rate of return" will increase, thereby increasing downstream demand.

The "expected price" of Bitcoin is the main reason affecting the "expected rate of return", and it can be inferred that the "expected price" of Bitcoin affects the downstream mining demand. There are four factors that affect mining income: algorithm, market, mining farm, and hardware . We will not elaborate on the specific factors here. Among the four influencing factors, market factors play a dominant role, mainly because the price of Bitcoin fluctuates more than other factors. Take Canaan's Avalon Miner A721 as an example. When denominated in Bitcoin, its daily mining income decays exponentially over time, which is mainly caused by the continuous increase in the computing power of the entire network; when denominated in US dollars, its daily mining income changes over time. The trend is similar to the Bitcoin price time curve. This fully shows that the biggest factor affecting mining income is still the Bitcoin price. From this extrapolation, the main factor affecting the "expected rate of return" is the "expected price" of Bitcoin.

To further refine the above view, mining machines can be regarded as a "call option" on the price of Bitcoin . When miners buy mining machines, they obtain a relatively certain amount of Bitcoin in the future at a certain price (although the future computing power of the entire network is uncertain, the approximate range can be estimated), and the idea of ​​miners buying mining machines comes from their expectation that the price of Bitcoin in the future will be higher than now, resulting in "expected mining income" higher than the current mining income, bringing excess income. From this perspective, it is equivalent to miners being able to buy Bitcoin at a price lower than the market price in the future, and mining machines can be regarded as a "call option" on the price of the currency.

The global blockchain hardware market has a large space and a fast growth rate, which will be close to 50 billion in 2018. Blockchain-related hardware equipment is mainly used for cryptocurrency mining. According to Frost & Sullivan statistics, the sales revenue of global blockchain hardware has increased from 70 million yuan in 2012 to 19.3 billion yuan in 2017, with a compound annual growth rate of more than 200%. At the same time, the widespread application of blockchain technology in various industries in the future will drive the growth of blockchain hardware demand. In the next three years, the market will maintain an overall annual compound growth rate of 72%. In 2018, the global market size will reach 45.6 billion. By 2020, the global blockchain hardware market size will be close to 100 billion.

Different from the market's view that the mining industry has entered a cold winter, we believe that the demand for new computing power is still in a stage of rapid growth, and the neutral judgment is that the year-on-year growth rate in 2018 will reach 165% . Affected by the decline in the Bitcoin market since the beginning of the year, the price of the currency and mining income have fallen sharply, which has led to a slowdown in the growth of new mining machine demand. However, through the data, we found that if $10,000 is used as the expected price of BTC in the rest of 2018, 39,930 PH/S of new computing power will be generated in 2018, an increase of 165% year-on-year. Although it has decreased compared with last year, such a growth rate shows that the demand for computing power is still in a stage of rapid development. The essential reason is the following four factors:

1. Mining machine products are updated very quickly, and high-performance mining machines drive demand development;

2. The price of mining machines has fallen along with the price of coins and mining revenue, so the static payback period for mining machine investors has not changed significantly;

3. The current price of the currency is relatively low, and most mining machine investors are optimistic about the BTC market in the second half of the year, so they choose to buy mining machines at this time;

4. There are always some areas in the world where electricity prices and rents are low, which continue to drive the demand for local mining.

Since the price of BTC fluctuates greatly, we used the price of BTC as an influencing factor to conduct a sensitivity analysis of the new computing power demand in 2018. When the expected price is $6,000 (pessimistic expectation), $10,000 (neutral expectation), and $14,000 (optimistic expectation), the corresponding new computing power demand is 29,000, 40,000, and 50,000 PH/s, with a year-on-year growth rate of 96%, 165%, and 235% compared with 2017.

It is worth noting that from the data up to June, the data of mining machine manufacturers is still good, but if the BTC price remains the same or even falls further, the shipment situation of manufacturers in the second half of the year is very likely to deteriorate. The reason is that at the beginning of the year, the price of coins was high, and many miners bought mining machines at high prices to enter the market (the spot price of S9 in the secondary market was once as high as 30,000, but now it is less than 4,000). This part of the investment has been "silent". As long as it is higher than the variable cost (electricity, manual operation and maintenance, etc.), mining machines will continue to be invested in, hoping that the BTC price will rebound, but at the same time, external investors may be deterred and more cautious about purchasing mining machines.

The global Bitcoin mining machine market presents an oligopoly pattern

Taking Bitcoin ASIC mining machines as an example, Bitmain and Canaan Creative together account for more than 80% of the market share. In terms of the delivery volume of mining machines in 2017, Bitmain alone accounted for nearly 70%, and Canaan Creative accounted for about 20% . Rapid and powerful R&D capabilities, strong capital guarantees, good relationships with upstream foundries, and economies of scale are all unique resources firmly grasped by industry leaders. Correspondingly, they enjoy the top market share and absolute product pricing power.

By comparing products, we can find that the market leaders Bitmain and Canaan Creative have advantages in the two core parameters of their products ("power consumption per unit of computing power" and "price per unit of computing power"). The continuous release of new products every year also proves the sustainability of the research and development capabilities of these two companies. In comparison, other mining machine suppliers may have problems such as insufficient scale effect, overpriced products, and insufficient series development capabilities. These two companies will continue to maintain their leading position in the Bitcoin market in the future.